Wednesday, September 7, 2016

Thrifty Thinking: Consumer Debt

1.How did consumer credit card debt get up to $12 trillion?
Consumer credit card debt is only a small subset (less than $1
trillion) of the
$12 Trillion total household consumer debt (which includes mortgage and
other types of debt, like auto, personal and student loans). Credit
card debt has been growing in recent years, but is still not quite to
the level it was prior to the financial crisis.
The main difference between then and now is that consumers are better
able to handle credit card debt as evidenced by historically low
delinquency rates, which wasn't the case prior to the great recession.
The reason it has grown in recent years is that
the economy is better and we are almost at full employment, which gives
consumers the confidence to spend more and carry more debt.

2.Why does this particularly hit consumers with low credit?
Lowerincome
people are typically hit harder by credit card debt because they must
pay higher interest rates due to being considered higher credit risks by
lenders. This segment of the market also tends to pay
more in annual fees and late fees and are more squeezed by their
financial conditions, making it harder to pay off balances in full and
are more often left to carry balances and pay those higher interest
charges. This can cause a downward spiral of debt that
can reach levels where people can't even pay their minimum amounts due
and potentially go into default.

3.How can people break the habit of credit card debt?Credit
card debt can insidiously build up over time, especially when only
paying the minimum payment due and adding to the balance with new
charges each month. To break that cycle it's best to stop using credit
cards to
pay for things that one can't afford to pay cash for to begin with.
Paying by credit separates the purchase and payment process
and psychologically makes it easier to spend more over time, as it feels
like less of a sacrifice vs. spending cash. By focusing
on paying off existing card balances over time without adding to them
is the best way to break that cycle.

4.What if people are struggling to get by - how can they start to reduce their debt?Only paying
for essentials and using cash or checks or debit cards for payment
methods can help keep people within their financial means while avoiding
the use of credit cards to borrow to pay for everyday living. Many
things that seem essential are really quite discretionary when money is
tight - whether it's an iPhone, cable TV or daily Starbucks coffee
things that seem like imperatives can be cut out without causing undue
hardship and often have lower cost or free alternatives. Bottom
line - the only way to get out of debt is to live below one's means and
use the savings to chip away at outstanding debt balances.